Friday, May 8, 2009

At one bank in Alabama, the problem is a construction bust. At two in Ohio, the trouble is real estate. And in San Francisco, at Wells Fargo, the worry is credit cards — a staggering 26 percent of that bank’s card loans, federal regulators have concluded, might go bad if the economy takes a turn for the worse.

The stress tests released by the Obama administration Thursday painted a broad montage of the troubles in the nation’s banking industry and, for the first time, drew a stark dividing line through the new landscape of American finance.

On one side are institutions like JPMorgan Chase and Goldman Sachs, which regulators deemed stronger than their peers — perhaps strong enough to repay billions of bailout dollars and wriggle free of government control.

On the other side are weaker institutions like Bank of America, which now confront the daunting challenge of raising capital on their own or accepting increased government ownership, along with whatever strings might be attached. Time is short: the banks have only until June 8 to draw up their plans for regulators. As the results of the tests streamed in from the Federal Reserve, banks began racing to raise money.

Broadly speaking, the test results suggested that the banking industry was in better shape than many had feared. Of the nation’s 19 largest banks, which sit atop two-thirds of all deposits, regulators gave nine a clean bill of health. The remaining 10 were ordered to raise a combined $75 billion in equity capital as a buffer against potential losses should the economy deteriorate. That amount is far less than many had forecast. But the potential losses that federal regulators projected, even at the soundest banks, are eye-popping.

Under regulators’ worst-case assumptions, the 19 banks might suffer $600 billion in losses through 2010, on top of the hundreds of billions that have already vaporized in this financial crisis. About 9 percent of all loans might sour — a figure that is even higher than it was during the Great Depression. One in five credit card loans could go unpaid, more than double the typical loss rate. Approximately one in 10 mortgages could sour.

The tests also left some crucial questions unanswered, including the big one: What happens if this recession turns out to be even worse than that worst-case situation, and the banks’ losses start growing? The results suggest the big bailouts for the banks are over. But many wonder if banks will be in a position to make the loans needed to revive growth, even under rosier economic assumptions.

“Everybody should breathe a sigh of relief,” said Peter J. Solomon, who runs a boutique investment bank and early in his career worked at Lehman Brothers. “Now the question is, So what? Will they lend?”

The results shined an uncomfortable spotlight on the most troubled financial institutions: GMAC, the finance arm of General Motors; Bank of America; Wells Fargo; and Citigroup. Several large regional banks — like Regions Financial in Alabama and SunTrust Banks in Georgia, and Keycorp and Fifth Third in Ohio — were also deemed to need large sums of capital.

But many banking executives, free to discuss the results publicly for the first time, sought to put a positive spin on the tests. In a rush of conference calls with analysts, they generally characterized the results as a sign that their institutions could weather another downturn in the economy. Many said federal regulators were overly pessimistic in their assessments and insisted that they would move quickly to repay bailout money.

“Our game plan is to get the government out of our bank as quickly as possible,” said Kenneth D. Lewis, the chief executive of Bank of America.

But even Mr. Lewis acknowledged that his bank faced some serious challenges. Regulators determined that Bank of America needed to raise about $34 billion in equity capital. The bank hopes to raise half of that by selling common stock and converting preferred shares to common stock. It hopes to raise the rest by selling assets like First Republic Bank and Columbia Management, its Boston-based investment unit, and using its future earnings. If that fails, the bank will have to convert some of the $45 billion of preferred stock that the government owns into common shares, increasing the government’s stake.

Even before federal regulators announced the results of its stress tests, Wells Fargo announced that it would offer $6 billion in common stock. The government is requiring the bank to raise an additional $13.7 billion.

Wells executives — who balked at accepting bailout money last autumn — said they expected to raise the remainder largely through revenue growth that they say they believe will far exceed the expectations of government regulators.

But Wells Fargo officials also disputed the government’s conclusions, arguing that the government’s revenue forecasts were “excessively conservative.”

“In our analysis, we thought we didn’t need any capital,” said John Stumpf, the bank’s president and chief executive.

Citigroup, which for many has come to symbolize the problems plaguing the financial industry, has already been moving quickly to address its problems. Regulators determined that the bank must raise $5.5 billion, on top of recent efforts to raise capital by selling businesses and converting just over half of the $45 billion in bailout funds to common stock.

Vikram S. Pandit, the bank’s chief executive, said he would expand the company’s offer to exchange preferred shares of stock for common stock to a broader assortment of private investors. The moves will severely dilute the bank’s shareholders and will leave the government with a 34 percent ownership stake, slightly less than investors expected.

“We have had to make some very tough decisions,” Mr. Pandit said. “We are kind of happy we did them along the way.” But a handful of stronger banks are pulling away from their weaker peers and emerging as institutions that could dominate the industry.

Goldman Sachs, for instance, has said that it hopes to return the $10 billion it received from the government as soon as possible. On Thursday, regulators said Goldman did not need more capital.

JPMorgan Chase, which was also deemed to have enough capital, is pushing to return bailout money as well. Yet it, too, took issue with the results, arguing it was in an even stronger position than the results suggested.

“We think we can handle an even more significantly negative environment and still make a profit,” Michael J. Cavanagh, chief financial officer, said.

For Washington and Wall Street, the main question is whether investors and depositors will take solace from these results. Banks and administration officials are eager to persuade private investors that the banks are stable enough to invest in.

“The golden ring here, if you can catch it, is confidence,” said Tanya Azarchs, the bank rating analyst at Standard & Poor’s.

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